Dumb Money Can Shape Short 'Bases' That Aren't Bases

If we're honest, most longtime investors can recall when they provided the dumb money for a stock's last gasp.

Two factors shape dumb money.

First, dumb money is late to discover a stock. The stock has had a long run. The smart money has done well, and it's happy to sell.

Second, dumb money is anxious money. At some level, the dumb money realizes it's late to the party. If you're late to the stock market party, what do you do? You rush to buy shares before the price gets too dear.

Now, let's change the subject, but only because the new subject is relevant to this discussion.

IBD research has found certain minimum lengths are necessary to proper bases — at least seven weeks for a cup with handle; six weeks for a cup without handle; and five weeks for a flat base.

Sometimes people ask why a short base is bad. What's so special about seven weeks or more for a cup with handle?

The short answer is this: Don't worry about the cause. Stay focused on the effect. Your goal is to make good investments, not philosophize.

Philosophers do not make great investors. Or as a professor friend once said, "You can't appoint anybody from the philosophy department to a committee. You'll never get a quick decision out of them."

Yet, if a philosophy professor is reading this, he or she probably noticed something by now. All that skill in symbolic logic makes progressions easy to see.

Dumb money is late to the market party. Dumb money is anxious to buy shares of the hot stock. Therefore, dumb money will drive breakouts from short bases because it cannot wait.

And that's one more reason to ignore short "bases." It's the signature of dumb money.

MercadoLibre (MELI) broke out of an 11-week cup with handle in March 2009. 1 It was part of a base following the devastating 2008 bear market. The online marketer rose 218% in about nine months. 2

By Christmas, the stock completed a pattern that looked like a base but was only three weeks long. 3 The little pattern's right side involved seven straight up days in lackluster volume.

The pattern was too short to be a base. The stock fell 33% in the next six weeks.

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